All Bets are On! Gambling and Video Games How the Evolution of Games Has Led to a Rise in Gambling Concerns September 2018 By: James G. Gatto and Mark A. Patrick Recently, there has been a frenzy of legal activity with U.S. gambling laws and the number of gambling- related legal issues with video games. U.S. gambling laws have changed more in the past few years than they have in a long time. Significant state law changes have occurred concerning online gambling, sports betting, fantasy sports, and skilled-based games, to name a few. Some significant recent changes under federal gambling law have also occurred. The evolution of certain aspects of games by the game industry— particularly those involving loot boxes, casino-style games, and chance-based mechanics with virtual items— has raised the perception of certain gambling-related issues. Despite being prohibited by game publishers, players’ engagement in unauthorized activities (e.g., selling virtual items on secondary markets and “skin gambling”) have exacerbated these issues. The financial success of these monetization techniques has led to greater legal scrutiny. The rise of eSports has also implicated sport betting issues. The gambling-related legal issues with video games are still being resolved. A significant debate is occurring. Some argue the game industry is so profitable because it delivers a compelling entertainment experience to a broad demographic of people who are willing to pay for that entertainment. Others claim games have become addictive and include elements that constitute gambling. This paper will not resolve that debate. However, it will: • provide an overview of US gambling laws; • address significant, recent changes in US gambling laws; • identify factors that have led to the rise in gambling issues with video games; • summarize recent enforcement activity involving games; and • provide some perspective on what may lay ahead. www.lawofthelevel.com Overview of Gambling Laws in the US and Recent Changes Gambling is regulated in the United States via federal and state laws. With few exceptions, most of the substantive laws defining gambling are state laws. Most states’ laws prohibit illegal lotteries and separately prohibit illegal gambling. In states where lotteries are legal, they typically authorize state-run lotteries, but prohibit private-sector lotteries. In most states, an illegal lottery involves three elements: 1. Payment of some form of consideration 2. A result determined by chance and not skill 3. A prize This is often referred to as the prize-chance-consideration test. In general, if all three of these elements are present, that offering may be an illegal lottery and may also constitute illegal gambling. If at least one of these elements is removed, the offering will generally fall outside the anti-lottery/gambling laws. If payment of consideration by the user is eliminated, then the result is typically a sweepstakes. If chance is eliminated, the activity can be a skill-based contest. While these three elements seem to be fairly simple terms, their interpretation is not. Their meaning varies from state to state. Many states gambling statutes include factors similar to the prize-chance-consideration test for lotteries. However, the gambling laws can and do differ from the lottery laws. Many gambling statutes require something more than just any form of consideration. Gambling typically requires making a “bet or wager.” Details on what constitutes a bet or wager are provided below. A number of courts have ruled that not every payment for a chance to win a prize is a bet or wager.1 This is a commonly misunderstood issue. As detailed below, this can be significant to games where players pay to buy virtual items. Paying for goods or services is typically not a bet or wager, but rather a bona fide commercial transaction. Many states expressly exempt from their gambling laws bona fide business transactions enforceable under the law of contracts. One important requirement under most states’ gambling laws is that the thing “bet or wagered” and the prize or thing won must be a “thing of value.” Money and tangible property are often things of value. But when virtual items (e.g., virtual currency or virtual casino chips) are at issue, the analysis is not always so easy. For example, if an online game player puts up virtual currency for a chance to win virtual items which cannot be cashed out, has he or she staked a thing of value and/or won a prize that is a thing of value? This question is central to a number of ongoing legal disputes involving the question of whether certain games involve gambling. Secondary markets (often unauthorized) can complicate the analysis. These issues will be addressed in detail below.<?> 1 See, e.g., Humphrey v. Viacom, 2007 U.S. Dist. LEXIS 44679, at *25-28 (D.N.J. June 20, 2007) (determining that the fees paid to the fantasy sports game operator were payment for services pursuant to an enforceable contract, and thus the player had no “gambling loss”). 2 The analysis of whether virtual items have value may depend on many factors, including: (i) how the player acquired virtual currency (e.g., whether it was paid for with real cash or earned through game play); (ii) what the player can do with the virtual currency (e.g., cash it out for real money or real-world goods, or just use it in a game to acquire virtual goods, which themselves may or may not have extrinsic value); (iii) with whom can it be used (e.g., the virtual currency issuer or third parties); and (iv) the definition of thing of value in the individual states gambling statutes. www.lawofthelevel.com Historically, some of the most important federal gambling laws are those provided immediately below. Other federal gambling statutes are primarily enforcement statutes and do not define what constitutes gambling.3 • The Unlawful Internet Gambling Enforcement Act (“UIGEA”) – The last new federal gambling legislation, enacted in 2006, UIGEA is primarily an enforcement statute. It forbids financial institutions from processing payments associated with certain illegal gambling activity. The act itself does not define what constitutes unlawful gambling, but instead generally refers to activities that are deemed illegal gambling under other federal or state law. Federal gambling law remained static after the enactment of UIGEA until two important changes occurred. The first was the reinterpretation of the Wire Act. The second was the declaration of PASPA as being unconstitutional. • The 1961 Wire Act (“Wire Act”) – Until 2011, this law prohibited use of most interstate telecommunications mediums for transmitting bets or wagers, or information assisting in placing bets or wagers, on any sporting event or contest. This had been interpreted to prohibit all forms of gambling across state lines (i.e., sports events and any other contests). However, in December 2011, the Department of Justice (DOJ) issued a memo that declared that the scope of the Wire Act is limited to sports betting. As a result, states became free to legalize online gambling (other than sports betting). A number of states have done so and others are in the process of doing so. • The Professional & Amateur Sports Protection Act (PASPA) – Until the Supreme Court struck down PASPA as unconstitutional, it prohibited most sports betting.4 The Supreme Court’s declaration that PASPA is unconstitutional paves the way for states to legalize intrastate sports betting.5 However, due to the Wire Act, most interstate sports betting is still illegal. State gambling laws have changed at a more rapid pace. The following is an overview of some areas where state gambling have recently changed. • FANTASY SPORTS – For many years, season long fantasy sports leagues thrived. With limited exceptions, the legality of fantasy sports was not challenged. Over the past few year, some fantasy sports upstarts evolved the business model from season-long to daily fantasy sports (DFS). The advent of DFS, coupled with the aggressive marketing and huge prizes offered by some of the industry leaders, led to a flurry of legal activity. This activity included enforcement actions by the New York Attorney General and others. The end game is still playing out, but a number of states have passed legislation to legalize DFS, subject to licenses, taxes, and other conditions. Other states have banned DFS through legislation or AG 3 The Travel Act and the Illegal Gambling Business Act are both primarily enforcement statutes and require a finding of a violation of a state law as a predicate to their applicability. The Travel Act prohibits using any facility in interstate or foreign commerce with the intent to promote, manage, establish, carry on, or facilitate unlawful activity. The Illegal Gambling Business Act prohibits financing, owning, or operating an illegal gambling business. 4 Because some states (Nevada, Oregon, Delaware and Montana) already had state-authorized sports wagering before the enactment of PASPA, statutory exceptions allow them to continue permitting certain sports betting. 5 See Murphy v. NCAA, 138 S. Ct. 1461 (2018) (striking down the prohibition of state authorization of sports gambling under PASPA as unconstitutional). www.lawofthelevel.com opinions. Some states have not yet acted. This has lead to a patchwork of regulation, requiring fantasy sports operators to exclude players from a number of states. • ONLINE GAMBLING – In response to the DOJ memo on the Wire Act, a number of states passed legislation authorizing certain online gambling activity. • SPORTS BETTING – The sports betting market in the U.S. is estimated by some to be a $100 billion market. Much of that represents illegal sports betting. Despite the huge appetite of U.S. sports bettors, most sports betting had been illegal in the U.S. due to PASPA.